Hedge Fund Share Classes and FX Exposure

The choice between offering different currency share classes (e.g., USD, EUR, GBP) or hedging currency exposure back to a base currency (e.g., from EUR into USD) depends on your hedge fund’s structure, investor base, and operational preferences.

Each approach has distinct advantages and trade-offs:

Option 1: Multiple Currency Share Classes

Pros

• Investor Convenience: Investors can subscribe in their preferred currency, avoiding FX costs on entry/exit.
• Marketing Appeal: Especially useful for European, UK, and Asian investors who may want to minimize FX exposure.
• NAV Clarity: Each currency class has its own NAV, giving investors a clear performance picture in their own currency.

Cons

• Operational Complexity: Requires separate accounting and reporting for each class.
• Increased Admin Costs: Fund administrator must maintain parallel NAVs and potentially apply currency hedging at the share class level.
• Fragmented Liquidity: Smaller AUM per share class can dilute fund efficiency and may complicate performance tracking and reporting.

Option 2: Single Base Currency with Currency Hedging

Typically, the fund is denominated in one base currency (e.g., USD), and currency hedging is used to protect foreign investors (e.g., EUR investors) from FX fluctuations.

Pros

• Centralized Liquidity & NAV: Easier portfolio and liquidity management.
• Simplified Operations: Only one NAV and no need to manage multiple share classes.
• Professional Appearance: Shows that FX risk is actively managed, which can appeal to institutional investors.

Cons

• Hedging Costs & Slippage: Currency hedging strategies (e.g., FX forwards or NDFs) have costs that can erode performance.
• Imperfect Hedge Risk: Hedging might not fully protect against FX volatility, especially during large inflows/outflows or extreme market moves.
• Investor Confusion: Investors may not fully understand how hedging works or how it affects their returns.

Best Practice in the Industry

Many institutional hedge funds do both:

• Offer multi-currency share classes (USD, EUR, GBP, CHF, JPY, etc.)
• Apply class-level FX hedging so that each non-base share class is hedged back to the base currency using FX forward contracts

This allows:

• Reporting in investor’s home currency
• Reduced FX risk at the share class level
• Operational integrity with a single base currency portfolio

Conclusion

For a Cayman hedge fund targeting international investors, especially under the CV5 Capital platform:

• Use USD as the base currency
• Offer EUR, GBP, CHF, and JPY share classes (depending on investor demand)
• Apply class-level FX hedging (e.g., 1-month rolling FX forwards) to reduce FX volatility on non-USD share classes
• Clearly disclose hedging approach, costs, and residual risk in the Offering Memorandum